Mediterranean Journal of Social Sciences
ISSN 2039-2117 (online)
ISSN 2039-9340 (print)
MCSER Publishing, Rome-Italy
Vol 5 No 24
November 2014
Applying the Category of «Assertions (or Preconditions)»
In Audit of Financial Statement
Kharisova F.I.
Kozlova N.N.
Kazan Federal University, Institute of Management, Economics and Finance, Kazan, 420008, Russia
Doi:10.5901/mjss.2014.v5n24p180
Abstract
The article considers the problems of applying the category of financial statement assertions (or preconditions) during the audit
of financial statement. It is suggested to apply the financial statement assertions to assess the audit risk’ components, test of
controls, planning an audit. The purpose of this paper is to present the significance of financial statement assertions in audit
practice. In ISA and the Russian standards on audit different aspects of applying preconditions of financial statement by the
auditor at all audit stages are presented.
Keywords: financial statement assertions, audit risk, International standards on auditing (ISA), financial reporting framework, the
preconditions of financial statement.
1. Introduction
Researching the category of “financial statement assertions” (or “the preconditions of financial statement”) is extremely
actual for the developing of audit methodology, in scientific literature the necessity of formulation the whole concept of the
preconditions of financial statement is designated. These preconditions are indirectly mentioned as criteria according to
which the assessment of auditor evidence is carried out. In 2003 year commenting on Federal standard on auditing No. 5
"Audit evidence" N. A. Remizov emphasized that "… almost all ISA is based on the concept of preconditions of financial
statement. Fundamental concepts of materiality, auditor risks, preparation of audit programs (without speaking about
audit evidence as those) are based on this concept" [1, p.138].
According to ISA “assertions” means representations by management, explicit or otherwise, that are embodied in
the financial statements, as used by the auditor to consider the different types of potential misstatements that my occur.
According to the Order of the Russian Federation Ministry of Finance of 16.08.2011 No. 99n is approved the
Federal Standard on Audit (FSA) ʋ 7/2011 "Audit evidence" according to which preconditions of financial statement are
assertions in an obvious or implicit form by entity’s management concerning recognition, an assessment and disclosure in
financial reports. According to this standard as a part of financial statement assertions are presented: completeness,
occurrence, accuracy, the rights and obligations, classification, valuation, existence, reference by the period, clearness
[2, p.227].
2. Theory
The contextual analysis using the concept of "financial statement assertions" ("preconditions of financial statement
preparation"), implemented by Vasilenko A.A. showed that the preconditions of financial statement are connected first of
all with risk of material misstatement (38 mentions), audit evidence (37 mentions), audit procedures (28 mentions) [3,
p.35].
Auditors are obliged to assess risks of material misstatement at two levels. First, at the level of financial statement
as a whole. It concerns risks of material misstatement which are mentioning financial statements as a whole and
potentially affect many assertions. The second level is related to the risks identified with specific assertions at the class of
transactions, account balance, or disclosure level. It means that for each account balance, a class of transactions and
disclosure, the risk assessment (such as high, moderate, or low) has to be made according to each separate assertion.
Generalization of points ISA 315 "Identifying and assessing the risks of material misstatement through
understanding the entity and its environment" about the preconditions of financial statement confirming appropriate
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ISSN 2039-2117 (online)
ISSN 2039-9340 (print)
Mediterranean Journal of Social Sciences
MCSER Publishing, Rome-Italy
Vol 5 No 24
November 2014
categories of financial information is given in table 1.
Table 1. The link between financial statement assertions and confirmed categories of financial information
Categories of financial
information
Financial statement assertions
which confirmed categories
Description
Transactions and events that have been recorded have
occurred and pertain to the entity
All transactions and events that should have been
Completeness
recorded have been recorded.
Classes of transactions and
Amounts and other data relating to recorded transactions
Accuracy
events for the period under
and events have been recorded appropriately
audit
Transactions and events have been recorded in the
Cutoff
correct accounting period
Transactions and events have been recorded in the
Classification
proper accounts
Assets, liabilities, and equity interests exist
Existence
The entity holds or controls the rights to assets, and
Rights and obligations
liabilities are the obligations of the entity
All assets, liabilities and equity interests that should have
Account balances at the period Completeness
been recorded have been recorded.
end
Assets, liabilities, and equity interests are included in the
financial statements at appropriate amounts and any
Valuation and allocation
resulting valuation or allocation adjustments are
appropriately recorded.
Occurrence and rights and
Disclosed events, transactions, and other matters have
obligations
occurred and pertain to the entity
All disclosures that should have been included in the
Completeness
financial statements have been included
Presentation and disclosure
Financial information is appropriately presented and
Classification and understandability
described, and disclosures are clearly expressed.
Financial and other information are disclosed fairly and at
Accuracy and valuation
appropriate amounts
Occurrence
The importance of assertions is traced in definition of the audit risk components presented in ISA and Guide to Using
International Standards on Auditing in the Audits of Small- and Medium-Sized Entities.
The inherent risk is a susceptibility of an assertion about a class of transaction, account balance, or disclosure to a
misstatement that could be material, either individually or when aggregated with other misstatements, before
consideration of any related controls [4, p.32].
For example, if the subject has the high cost inventories which could be easily stolen, there will be an inherent risk
concerning the assertion about existence. This assessment of risk ignores an installed system of internal control for
protection of such inventories.
Responding actions to an inherent risk are undertaken both at the level of financial statements, and at the level of
assertions.
Control risk - risk that a misstatement that could occur in an assertion about a class of transaction, account
balance, or disclosure and that could be material, either individually or when aggregated with other misstatements, will
not be prevented, or detected and corrected, on a timely basis by the entity’s internal control.
It belongs to the risk of that the entity’s controls (are developed to reduce any concrete risk) won't be able to work
properly, leading to misstatement. Thus the entity’s management has to identify and estimate the enterprise and other
risks (such as fraud) and to make response it by organization and introduction of internal control system. Entity’s controls
of a certain level, such as supervision from board, the general controls in information technologies, and management
policy of human resource extend on all assertions whereas controls of activity on a certain level usually concern certain
assertions.
Detection risk means risk of that the auditor will not detect a misstatement which exists in the assertion and that
could be material, either individually or when aggregated with other misstatements.
The acceptable level of detection risk for this level of audit risk is inversely proportional to the risks of material
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November 2014
MCSER Publishing, Rome-Italy
misstatements at the level of assertions.
3. Results
For identification and assessment of audit risk components it is offered to be guided by financial statement assertions that
can be reflected in a working paper such form (table 2) [5].
Table 2. The register of risks
ʋ
The risk factor
3
Probability
(from 1 to 5)
4
Assessment of risk (the influence on
assertion) (from 1 to 5)
5
Risk
value
6= 4*5
Valuation
3
4
12
…
…
…
…
Assertion
1
2
The new technology considerably reduces
production expenses on some products.
2
…
Note: 0-10 – low level of risk; 11- 18 – average level of risk; 19-25 – high level of risk.
"The register of risks" can be also used to document risk factors of fraud (table 3).
Table 3. The register of risks concerning fraud
ʋ
ɩ/ɩ
That can go not so as a
result of fraud
The identified risks
Intense situation with cash flows
because of overdue delivery
according to the large contract
…
1
2
The influence on financial statement
Risk assessment
assertions
Report on
Risk
Assets Obligations
Probability Influence
financial results
value
The owner can try to hide
valuation completeness
losses
accuracy
3
3
9
…
In case such list is documented in a spreadsheet, risks can be sorted on the basis of probability values, influence, or the
combined risk value. For determination a documenting way of these matters it is necessary to use professional judgment.
For testing assessment of risks and internal controls we also suggest to consider financial statement assertions. As
an example tests of risk assessment and the controls connected with derivative financial instruments are submitted (table
4 and 5 respectively) [6, p.1189].
Table 4. Test of risk assessment connected with derivative financial instruments (fragment)
ʋ
1
Financial statement
assertions
Completeness,
accuracy, occurrence
Test of risk assessment
Test
result
Symbols
Y1-Y4
Does entity have commercial risks?
Yes
Y1
Auditor
conclusions
Low level of
risk
Is it checked correctness of assessment model used
High level of
for determination of the price of a concrete financial
No
Y4
risk
instrument?
Valuation
Is it used credit risk in a model of assessment of
Low level of
3
Yes
Y1
financial instruments?
risk
…
…
…
…
…
…
Note: Y1 – Low level of risk, Y2 – risk level is lower than an average, Y3 – average level of risk, Y4 – High level of risk.
2
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Mediterranean Journal of Social Sciences
ISSN 2039-2117 (online)
ISSN 2039-9340 (print)
Vol 5 No 24
November 2014
MCSER Publishing, Rome-Italy
Table 5. Tests of entity’s controls connected with derivative financial instruments (fragment)
ʋ
ɩ/ɩ
Financial statement
assertions
Test
result
Tests of entity’s controls
Criteria
Estimate
(from 0 to
100)
Control environment
Do organization’s employees have a sufficient level of
Valuation, rights and
professional competence for an assessment of financial
obligations, classification
instruments?
Valuation, rights and
2
Does organization have branches or business?
obligations, classification
Does organization have clear formulated and approved by
Valuation, rights and
3
owner policy in the field of financial instruments purchase
obligations, classification
and sale?
…
…
…
Entity’s risk assessment process
Does management carry out a preliminary estimate of
Valuation, rights and
…
transactions proportionally to the risks connected with
obligations, classification
concrete financial instruments?
1
…
Valuation, rights and Is it established the limits of the risks connected with use of
obligations, classification financial instruments?
…
…
Entity’s information system
Valuation, rights and
…
obligations, classification
Valuation, rights and
…
obligations, classification
…
….
Entity’s control activities
…
…
Does the entity have functionality or an appropriate
configuration for operations with financial instruments?
Does entity use the electronic trading platforms for
transactions with financial instruments?
….
Completeness, accuracy, Is it carried out monitoring of trade transactions of
occurrence
individuals?
Completeness, accuracy, Is it carried out regular verification with banks and
…
occurrence
depositaries?
Is it existed the appropriate division of duties between
Completeness, accuracy,
responsible for carrying out operations and for their
occurrence
verification?
…
…
…
Monitoring of controls
….
average
no
high
average
low
yes
no
55
80
yes
yes
no
85
…
…
…
no
yes
no
15
no
yes
no
18
…
…
…
….
yes
no
yes
no
….
yes
yes
no
yes
no
82
81
…
86
not
regularly
yes
no
not
regularly
50
no
yes
no
10
…
…
…
yes
no
…
Is it carried out monitoring of operational statistical data?
no
10
as
necessary
Is it existed at organization’s computer systems function of
yes
…
no
10
generation reports on deviations?
no
…
…
….
…
…
…
Note: from 0 to 10% - no reliability of controls, from 11 to 40% - low reliability of controls, from 41 to 80 - average reliability of
controls, from 81 to 100 – high reliability of controls
Besides, it is offered to be guided by financial statement assertions on planning an audit. The example of the audit plan of
derivative financial instruments is provided in table 6.
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ISSN 2039-2117 (online)
ISSN 2039-9340 (print)
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Vol 5 No 24
November 2014
Table 6. The audit plan of derivative financial instruments (fragment)
ʋ Financial statement
assertions
1 Rights and
obligations,
occurrence,
2 Completeness,
Valuation, accuracy
… ….
Audit procedures
Document
Expended Method of
time (hour) audit
1.1. Legal assessment of contracts Contract, agreements;
4
Tests of
1.2. Expertise of contracts
copies of correspondence
controls,
or the expert opinion (in
substantive
case of its attraction)
procedures
2.1. Audit of the organization of primary Contract, agreements;
4
Tests of
accounting operations with derivative copies of correspondence
controls,
financial instruments 2.2. Check of
or the expert opinion (in
substantive
reliability (completeness and accuracy), case of his attraction)
procedures
registration efficiency of transactions
wih derivative financial instruments
…
…
…
…
Performer
Petrov
A.A.
Petrov
A.A.
…
4. Conclusions
The concept development of financial statement assertions is a separate large methodological problem of audit along
with research of the audit evidence concept and others concepts, known in the audit theory. In the last years researches
develop about material characteristics and different aspects of financial statement assertions. Enhancement of audit
methodology assumes detail reviewing of audit evidence and the preconditions of financial statement in the context of
standards on auditing. Collection of audit evidence in accordance with the preconditions of financial statement increases
reliability of audit evidence and efficiency of an audit inspection as a whole.
It is possible to recognize financial statement assertions as independent category of the audit theory along with the
categories "audit evidence", "audit procedures", "materiality", etc.
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